ON THE face of it, all seems to be going according to script for emerging markets so far this year. In the months after the US Federal Reserve indicated that it would start gradually "tapering" bond purchases to ease off on its expansionary quantitative easing policy, the conventional wisdom was that the effect on emerging markets would be to drastically reduce the inflow of dollars seeking yield.
And so it has apparently come to pass. US bond yields surged towards the end of last year as global liquidity felt the tightening effect of US monetary policy and a rising dollar, and portfolio inflows to emerging markets slowed then reversed, causing currencies such as the rand to depreciate sharply. Factor in concerns over the health of China’s banking system and forecasts of slower economic growth and reduced commodity imports by the world’s sweatshop, as well as some emerging markets’ unhealthily large current account deficits, and the outlook for both domestic bonds and equities appears still gloomier.
At the end of last week the broad MSCI emerging markets index was down 7.5% in a little over a month, and the yield spread between emerging market sovereign debt and comparable US Treasuries had widened by about 50 basis points, as was to be expected following the spate of emerging market interest rate hikes. However, there are some anomalies in the way the scene is playing out that indicate not everyone has read the script, and it emerges that not all of the assumptions that have underpinned market expectations up to now are entirely accurate.
Emerging markets were always going to be adversely affected by the reversal of the Fed’s ultra-loose monetary policy, just as they benefited from inflows when quantitative easing was implemented. But the effect may not be as bad or prolonged as many fear. And there are signs that some of the changes to the global economy that have taken place since the 2008 financial crisis are structural and permanent, meaning the patterns of the past will not necessarily be repeated in quite the same way.
Concerns over a repeat of the emerging market crisis of 1997-98 are almost certainly misplaced. For a start, the recent rush to disinvest from emerging market bonds and equities seems to have been driven almost entirely by retail investors, with institutional investors largely maintaining their positions and some even indicating that they intend increasing their holdings this year. A range of International Monetary Fund studies on the factors that drive global capital flows indicate there has been no substantial change to the fundamentals — emerging markets remain attractive to investors as a general class, although domestic issues in specific countries can always make them exceptions to the rule.
According to the Institute of International Finance’s latest capital flows report on emerging markets, the asset class now has a price-to-earnings (p:e) ratio for the coming 12 months of about nine times, well below the average of the past decade of 11 times. By comparison, developed markets are trading at a forward p:e of 15, well above the long-term average of 13. Yet emerging markets’ contribution to global gross domestic product (GDP) is substantially higher now than it was in 1997 — as much as 40%-50% compared with 5%-10% then. And many of the biggest "first world" companies are now dependent on emerging markets for much of their earnings growth. In addition, Africa and parts of South America continue to rise economically from an exceptionally low base despite the global hiccup. Investors can simply no longer afford to be out of emerging markets.
Research by Sanlam chief economist Jac Laubscher points to another reason we need not be overly concerned by the prospect of tapering causing a reversal of capital flows away from emerging markets — the inflow of the past five years was not as exceptional as is commonly believed. It amounted to a return to the prefinancial crisis level after a sharp contraction in late 2008, and as a percentage of global GDP the figure has already dropped to 1.5% from a peak of 2.5% in 2005.
Mr Laubscher says the improvement in emerging market fundamentals, their continuing financial development and the improved understanding of emerging-market economies among first-world investors, imply a need to "rethink the validity of the sudden stop paradigm".
Picture: THINKSTOCK
ON THE face of it, all seems to be going according to script for emerging markets so far this year. In the months after the US Federal Reserve indicated that it would start gradually "tapering" bond purchases to ease off on its expansionary quantitative easing policy, the conventional wisdom was that the effect on emerging markets would be to drastically reduce the inflow of dollars seeking yield.
And so it has apparently come to pass. US bond yields surged towards the end of last year as global liquidity felt the tightening effect of US monetary policy and a rising dollar, and portfolio inflows to emerging markets slowed then reversed, causing currencies such as the rand to depreciate sharply. Factor in concerns over the health of China’s banking system and forecasts of slower economic growth and reduced commodity imports by the world’s sweatshop, as well as some emerging markets’ unhealthily large current account deficits, and the outlook for both domestic bonds and equities appears still gloomier.
At the end of last week the broad MSCI emerging markets index was down 7.5% in a little over a month, and the yield spread between emerging market sovereign debt and comparable US Treasuries had widened by about 50 basis points, as was to be expected following the spate of emerging market interest rate hikes. However, there are some anomalies in the way the scene is playing out that indicate not everyone has read the script, and it emerges that not all of the assumptions that have underpinned market expectations up to now are entirely accurate.
Emerging markets were always going to be adversely affected by the reversal of the Fed’s ultra-loose monetary policy, just as they benefited from inflows when quantitative easing was implemented. But the effect may not be as bad or prolonged as many fear. And there are signs that some of the changes to the global economy that have taken place since the 2008 financial crisis are structural and permanent, meaning the patterns of the past will not necessarily be repeated in quite the same way.
Concerns over a repeat of the emerging market crisis of 1997-98 are almost certainly misplaced. For a start, the recent rush to disinvest from emerging market bonds and equities seems to have been driven almost entirely by retail investors, with institutional investors largely maintaining their positions and some even indicating that they intend increasing their holdings this year. A range of International Monetary Fund studies on the factors that drive global capital flows indicate there has been no substantial change to the fundamentals — emerging markets remain attractive to investors as a general class, although domestic issues in specific countries can always make them exceptions to the rule.
According to the Institute of International Finance’s latest capital flows report on emerging markets, the asset class now has a price-to-earnings (p:e) ratio for the coming 12 months of about nine times, well below the average of the past decade of 11 times. By comparison, developed markets are trading at a forward p:e of 15, well above the long-term average of 13. Yet emerging markets’ contribution to global gross domestic product (GDP) is substantially higher now than it was in 1997 — as much as 40%-50% compared with 5%-10% then. And many of the biggest "first world" companies are now dependent on emerging markets for much of their earnings growth. In addition, Africa and parts of South America continue to rise economically from an exceptionally low base despite the global hiccup. Investors can simply no longer afford to be out of emerging markets.
Research by Sanlam chief economist Jac Laubscher points to another reason we need not be overly concerned by the prospect of tapering causing a reversal of capital flows away from emerging markets — the inflow of the past five years was not as exceptional as is commonly believed. It amounted to a return to the prefinancial crisis level after a sharp contraction in late 2008, and as a percentage of global GDP the figure has already dropped to 1.5% from a peak of 2.5% in 2005.
Mr Laubscher says the improvement in emerging market fundamentals, their continuing financial development and the improved understanding of emerging-market economies among first-world investors, imply a need to "rethink the validity of the sudden stop paradigm".
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